Rising listed REIT valuations, troughing private commercial real estate prices, and rising CRE debt distress are sending a signal that there may be a light at the end of the tunnel for the broader CRE markets.
KEY TAKEAWAYS
- It is notable that listed REIT valuations have risen 38.5% as of the end of August since their bottom in October 2023 given the lead-lag relationship between listed and private real estate.
- Private valuations are 21% below their peak in the second quarter of 2022, and we expect them to trough over the next several quarters at around -25%.
- Year-over-year declines in transaction volumes troughed in the second quarter of 2023, while lending standards have stopped getting worse, both of which are indicators that private CRE may be bottoming.
Rising listed REIT valuations, troughing private commercial real estate prices, and rising CRE debt distress.
That’s what I am watching this month as we explore where we are in the CRE cycle.
Welcome to the Real Estate Reel from Cohen & Steers.
1. Listed REIT valuations
First, we’ve long argued that listed REITs are a leading indicator to private CRE in both downturns and recoveries.
Indeed, listed REITs were first to decline with total returns of approximately negative 25% in 2022, while private real estate valuations were still rising that year.
Listed REITs didn’t trough until late October 2023 with total returns down 33% from their peak at the end of 2021 (Exhibit 1). Price returns were -37.5% over that same period.
However, valuations since that bottom have risen 38.5% as of the end of August. In fact, real estate is the best S&P 500 sector since mid-April of 2024.
EXHIBIT 1
Listed REIT returns indicate private CRE may trough soon
At June 30, 2024. Source: Bloomberg, NCREIF and Cohen & Steers.
Data quoted represents past performance, which is no guarantee of future results.
In other words, given the lead-lag dynamic of listed and private real estate, we think listed REITs are sending a signal that there is a light at the end of the tunnel for the broader CRE markets.
2. Private CRE prices
This leads me to my second point: When will private CRE valuations trough?
Typically, private CRE bottoms 12 to 18 months after the trough in listed REIT valuations. This cycle appears to be playing out in similar fashion.
Unlevered property valuations are 21% below their peak in the second quarter of 2022.
We think private valuations have further to fall, but we expect them to trough over the next several quarters at around -25% based on our analysis of appraisal cap rates versus listed REIT implied cap rates.
We think it’s important to look at transaction values, which reflect the prices of properties that are actually being sold. That’s different than appraisal prices, which typically lag.
Notably, private real estate transaction valuations appear to have already corrected, as evidenced by open-ended funds that own core commercial real estate selling properties at nearly 6.5% cap rates in the first quarter of 2024, before tightening to 5.9% in the second quarter of 2024.
There are two important related signals that we watch that suggest most of the decline is behind the private CRE market.
First, year-over-year declines in transaction volumes troughed in the second quarter of 2023 with year-over-year declines of 59% (Exhibit 2). Transaction volumes appear to have stabilized in the second quarter of this year when they rose modestly year-over-year.
EXHIBIT 2
Real estate transaction volumes have bottomed
At June 30, 2024. Source: NCREIF, Senior Loan Officer Opinion Survey, Cohen & Steers.
Data quoted represents past performance, which is no guarantee of future results.
Second, lending standards as measured by the senior loan officer opinion survey, have stopped getting worse. Twenty two percent of respondents in the survey stated that they tightened lending standards in the second quarter of 2024 (Exhibit 3). That compares to a peak of around 68% who tightened in the first quarter of 2023.
EXHIBIT 3
Lending standards have stopped getting worse
At June 30, 2024. Source: NCREIF, Senior Loan Officer Opinion Survey, Cohen & Steers.
Data quoted represents past performance, which is no guarantee of future results.
These two signals are important because troughing in year-over-year changes in transaction volumes and lending standards have historically corresponded to a trough in property valuations.
It therefore shouldn’t come as a surprise that year-over-year changes in unlevered property valuations troughed at -13.4% in the third quarter of 2023 compared to -10.5% in the second quarter of 2024.
3. CRE debt distress
Our third and final point: It’s important to understand that debt distress is a lagging indicator for private CRE.
For instance, commercial mortgage-backed securities delinquencies peaked post the global financial crisis in July 2012, which was two and a half years after CRE valuations bottomed at the end of 2009 (Exhibit 4).
EXHIBIT 4
CMBS delinquencies took 2.5 years to peak after global financial crisis
At June 30, 2024. Source: NCREIF, Senior Loan Officer Opinion Survey, Cohen & Steers.
Data quoted represents past performance, which is no guarantee of future results.
Delinquencies for loans held on life company balance sheets and loans held on bank balance sheets both peaked 12-months after CRE valuations troughed post the GFC.
It’s entirely possible that private CRE market valuations are currently in the process of bottoming while distress in the lending markets is just beginning. They are not mutually exclusive.
Indeed, although distress is not as dire as the media might have you believe, delinquency rates are increasing across every lender type with CMBS 74bp higher year over year at nearly 5% as of July 2024, and we expect them to continue to rise through the remainder of 2024 and beyond.
Total distress stood at more than $94 billion as of the end of 2Q24 after rising for eight consecutive quarters, albeit it a decelerating rate in recent quarters. This is similar to levels last seen in 2013. This also means that the headlines surrounding CRE may become worse before they get better.
But we think this signals the final stages of acceptance in the grieving process of CRE declines. Overall, we believe this is a contrarian bullish signal.
Watch August 2024 The Real Estate Reel: The potential benefits of blending listed REITs and private CRE
Watch all The Real Estate Reel videos.
FURTHER READING
The Real Estate Reel: A closer look at Q3’s historically strong listed REIT returns
Listed REITs returned nearly 17% in the third quarter, handily outperforming equities, as lower real rates took hold in markets.
3 Reasons to own Listed REITs today
We see compelling evidence to own listed real estate in the current environment.
The Retail Renaissance has arrived in private real estate investing
Values of open-air, necessity driven shopping centers have bottomed; a reality that most investors have yet to fully recognize.
Data quoted represents past performance, which is no guarantee of future results. The information presented does not reflect the performance of any fund or account managed or serviced by Cohen & Steers, and there is no guarantee that investors will experience the type of performance reflected. There is no guarantee that any market forecast set forth in this video will be realized. There is no guarantee that any historical trend referenced herein will be repeated in the future, and there is no way to predict precisely when such a trend will begin. The mention of specific securities is not a recommendation or solicitation to buy, sell or hold any particular security and should not be relied upon as investment advice.
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Risks of Investing in Real Estate Securities. Risks of investing in real estate securities are similar to those associated with direct investments in real estate, including falling property values due to increasing vacancies or declining rents resulting from economic, legal, political or technological developments, lack of liquidity, limited diversification and sensitivity to certain economic factors such as interest rate changes and market recessions. Foreign securities involve special risks, including currency fluctuations, lower liquidity, political and economic uncertainties, and differences in accounting standards. Some international securities may represent small- and medium-sized companies, which may be more susceptible to price volatility and less liquidity than larger companies. No representation or warranty is made as to the efficacy of any particular strategy or fund or the actual returns that may be achieved.
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